“If [project organizers] cannot repay the loans, [the Ministry of Finance] will deduct money from the account of the local finance bureau that has provided a guarantee for the project even though the money has already been budgeted. That is the difference between foreign debt and domestic debt,” an official with the Henan Provincial government said.

Foreign debt refers to the sovereign debt borrowed from international financing agencies and foreign countries that is guaranteed by governmental fiscal revenue. This debt includes loans from the World Bank, the Asian Development Bank, the International Fund for Agricultural Development and foreign governments.

2010 marks the 30th anniversary of the cooperation between China and the World Bank. The World Bank has provided China with low-interest and interest-free loans worth 47.8 billion USD.

Presently China owes over 110 billion USD of foreign debt which entered its peak period of repayment in 2008.

The 110 billion USD worth of loans have been invested in over 2,000 projects covering transportation, health care, education, poverty-elimination and environmental protection. These loans increase in scope by approximately one billion USD per year.

The repayment periods of these low-interest and interest-free loans range from 10 to 40 years. They once accounted for half of China’s Foreign Direct Investment. Before 2000, they had been focused in fields such as transportation, infrastructure, energy, health care and education; but they shifted to poverty-elimination and environmental protection in central and western China after 2000.

“These foreign loans have a rigorous project selection process. We have to conduct a thorough investigation and a complete preparation for projects funded by foreign loans. While the project is carried out, it is monitored to see whether the money is being used correctly or wasted. Despite these qualifications, we still apply for foreign loans because [those agencies and countries] are willing to invest in non-profit projects in underdeveloped areas,” an official with the Ningxia Department of Finance said.

Foreign debt is currently guaranteed by the Ministry of Finance and the latter transfers the loan to those organizing the projects. The provincial finance departments are required to provide a “letter of guarantee” for these loans. If the parties responsible for the project are unable to repay the loans, the Ministry of Finance will directly deduct money from the account of the provincial finance department and the latter will then recoup the money from the finances of the county and city level government responsible for the project.

Though foreign debt has low interest rates and a long repayment period, they are still risky because of fluctuations in foreign currency exchange rates.

According to calculations by Shan Zhongdong, a professor with the Peking University China Center for Economic Research, from 1990 to 1992, China repaid 16.17 billion Yen to the Japanese government. Based on the exchange rate of Yen to US Dollar which was 145: 1 at the time when the loan was fully repaid, China repaid 110 million USDs while the Chinese government had initially only borrowed 70 million USD.

However, exchange rates are not the only risk.

Pressure on Local Governments

The Zhengzhou Municipal Government has just repaid a low-interest loan of 1.8 billion yuan to the World Bank, repaying decades worth of debt for a local company.

The company is Henan Zhongyuan Pharmaceutical. The loan was used to produce vitamin C from corn. But after the investment, the company was unable to create the product it had planned; the project was abandoned and Henan Zhongyuan Pharmaceutical was unable to pay back the loan.

Henan Zhongyuan Pharmeceutical’s domestic debt of 2.4 billion yuan was transferred to Xinda Asset Management Company and China Great Wall Asset Management Company. Its foreign debt of 1.8 billion yuan has been deducted from the account of the Henan Finance Department who will receive a yearly payment of 140 million yuan from the Zhengzhou Municipal Government until the debt is repaid. The EO has learned that Henan province owes one billion yuan in foreign debt that has been invested in projects.

“Because foreign debt is associated with a country’s reputation, there is no room for leeway; the debt has to be repaid. But many local governments who received loans transferred from national debt in the 1990s did not repay their loans,” an official with the Henan Department of Finance stated.

The central government, local governments, and project organizers do not dare to provide unclear data. When Jiaozuo, a city in Henan province, draws up its budget, it starts by examining its foreign debt.

From the Jiaozuo government budget we can see that in 2008, Jiaozuo had a transfer of foreign loans worth 73.64 million yuan which was mainly invested in preventing and treating disease. Because of this foreign debt, the municipal government has arranged make a yearly payment of 7.8 million yuan towards the loan.

“If we cannot afford to pay back our loans to the Industrial and Commercial Bank of China, we can get a new loan to repay the old, however we have to pay back foreign debt on time,” stated a Henan government official.

The Jiaozuo government has stated in its budgetary report that 2008 was the start of a peak period in foreign debt repayment and since then local finances have faced increased pressure.

“The local government has already made plans to use all of the money in its account. But upper level finance departments and the Ministry of Finance do not take this fact into consideration, so local governments have to redo their budget and many local government plans may be dropped,” stated a local official.

County-level governments are having an even tougher time. In Lainan County in Anhui province, because local project organizers are unable to repay their foreign loans, the provincial government is withdrawing large amounts from the fiscal budget of Laian County every year.

After the Wenchuan earthquake, the Ministry of Finance transferred 100 million USD worth of emergency loans from the Asian Development Bank to Shanxi Province and reduced its foreign debt by 598 million USD. The Ministry of Finance will repay the Asian Development Bank loans.

At the beginning this year, Jinzhou in Hubei province also applied for a reduction of its foreign debt invested in some public projects. The Ministry promised to solve this problem as soon as possible.